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Why Bigger Is Better for These Retailers

Does size matter? The debate on the right store size has divided retailers into two diverse camps, which side are you choosing?

If you have always associated Wal-Mart with Supercenters, you might have been surprised to see more Neighborhood Markets and Wal-Mart Express stores popping up in your neighborhood. With Wal-Mart, the pioneer of the big box format, announcing plans to accelerate the growth of its small-store format, it makes you wonder if this spells the death of the large-sized stores.

Notwithstanding this emerging trend, several U.S. retailers such as Whole Foods Market(NASDAQ:WFM), Burlington Stores(NYSE:BURL), and CST Brands(NYSE:CST) are either sticking with their large store format or moving in that direction.

Premium pricing and shopping experienceWhole Foods Market is the country's largest natural and organic food retailer, with a footprint of more than 300 stores. It also has the biggest store format among its peers, averaging 38,000 square feet per store. In contrast, the other listed natural and organic food retailers have significantly smaller average store sizes between 20,000 and 30,000 square feet.

There are two key reasons why Whole Foods Market is able and has to build larger stores.

First, Whole Foods Market charges premium prices for its high-quality natural and organic produce and boasts the highest gross margins among its peers at 35.7%. This means that it can afford to pay for the correspondingly higher rental costs associated with larger store spaces.

Secondly, apart from the quality of its food offerings, Whole Foods Market also has to provide a differentiated shopping experience to command a price premium. Specialized teams and dedicated customer service booths are made available in its stores to answer customers' queries and meet their needs.

It also offers sit-down eating areas and wine bars (in selected stores) to make shopping a communal experience where customers can mingle in comfort. This is something that its peers operating on a leaner model wouldn't be able to provide.

Whole Foods Market's strong revenue and net income CAGR of 12.8% and 30.9% in the past three years validates its investment in larger stores.

Source: Burlington Stores

Merchandising edgeTraditionally, off-price retailers have competed with department stores by focusing on a narrower selection of branded merchandise at lower prices and maintaining a more modest cost profile with smaller store sizes. The average off-price retailer's average store size of approximately 30,000 square feet is less than half of conventional department stores which are about 80,000 square feet large.

Burlington Stores has departed from the traditional off-price retailer model of smaller store formats, as its stores averaging between 50,000 and 80,000 square feet.

This has worked in Burlington's favor as it allows the company to have a wider product assortment. Although the exact number of SKUs isn't disclosed, Burlington claims to have greater product depth within the same product categories as its off-price peers. This will further enhance its customer drawing power relative to other off-price retailers.

Burlington's large store focus also complements its shallow merchandising strategy, where it stocks only a limited number of units for each style and relies on in-season opportunistic purchases. As a result, Burlington has the flexibility of allocating additional square footage to strong-performing categories and trending products.

The results speak for themselves. Burlington has outpaced off-price peers and department store operators for the past four years since 2010, growing sales by an impressive 6.2% CAGR. In contrast, department store sales were flat over the same period, while the off-price peer group expanded sales by an inferior CAGR of 5%.

Source: CST Brands

Customer convenienceWhat's good for customers is usually positive for retailers as well. Most truckers view the lack of parking lots as the key obstacle to shopping at certain convenience store locations. In response, CST Brands developed a new store format termed as "New-To-Industry" (NTI).The NTI stores are either 4,650 or 5,650 square feet large, making them much bigger than CST Brands' average store size of 2,350 square feet.

For example, CST Brands opened its largest store (10,100 square feet) in Three Rivers, TX in July 2013. This store provided ample parking for vehicles of different configurations, ranging from big rig trucks to motorcycles. Looking ahead, CST Brands is targeting 30 NTI stores in 2014, double of what was achieved in 2013.

In addition to accelerating large format growth via new NTI stores, CST Brands is also growing square footage through Raze & Rebuilds (R&Rs). Under R&Rs, existing stores are converted to new-format NTI stores, with store sizes expanded by more than 150%. Five R&Rs are planned for 2014.

Furthermore, larger stores will also come with expanded food offerings. Back to the Three Rivers store example, customers can look forward to freshly baked kolaches & whoopie pies, breakfast tacos with homemade tortillas, and more.

CST Brands' focus on larger store formats to meet the needs of customers has paid off. From 2009 to 2013, CST Brands has outperformed the convenience-store peer average every year in terms of profitability measured by the EBITDA/Net Assets metric.

Foolish final thoughtsThe big box model isn't dead, as detractors have claimed. The three retailers mentioned above have leveraged on their larger-sized stores to their advantage. Foolish investors should keep this in mind when evaluating their respective businesses.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

Mark is a private value investor and is the author of CheapskateInvesting.com website which uses a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders.